CFA LEVEL 2 FRA
FREQUENTLY TESTED ACTUAL EXAM QUESTIONS WITH
CORRECT ANSWERS
Question 1.
Mechanisms to misstate assets/liabilities (Biased Accounting)
ANSWER
- Choosing inappropriate models and/or model inputs that affect estimated values of financial
statement elements
- Reclassification from current to non-current
Over- or understating allowances and reserves
-Understating identifiable assets (and overstating goodwill) in acquisition method accounting
for business combinations
Question 2.
Internal Development Costs - R&D
ANSWER
IFRS
- Research costs are expensed as incurred
- Development costs are capitalized
GAAP
- R&D are expensed as incurred, except for software development costs
,Question 3.
Cash Flow Based Accruals
ANSWER
GAAP
-Div recieved, interest paid, interest recieved - CFO
-Div Paid - CFF
IFRS
-Div recieved - CFO if finance company, CFI otherwise
-Interest received - CFO, or CFI
-Interest paid - CFO (interest is part of normal biz), CFI
-Dividend Paid - CFO or CFF
Question 4.
Revenue Recognition Steps
ANSWER
1. Understand the rev recognition practices - shipping/credit terms, returns policy, multiple
deliverable, practices of peer group companies
2. Evaluate ageing of receivables - time series, cross sectional (peer group) comparisons
3. Cash vs accruals - cash vs accruals-based earnings evaluation
4. Compare financials with physical data provided by the company: Capacity utilization levels,
order books
5. Compare revenue trends to peers: use segment analysis
6. Check for related party transactions: transactions with associates, transfer pricing
,Question 5.
Consolidation of SPEs
ANSWER
IFRS consolidation when sponsor has control, indicated by:
- SPE benefits sponsor
- Sponsor makes decisions
- Sponsor absorbs rewards and risks
- Sponsor has residual interest
GAAP says an SPE is a VIE (and must be consolidated) if any are met:
- Insufficient risk. Investment in equity is less than 10% of assets
- Major shareholders lack decision making rights, and don't absorb expected losses, and do
not receive expected residual retirms
Question 6.
Lease Disclosures
ANSWER
Required to disclose:
- Lease payments for each of the next five years
- Aggregated payments beyond 5 years
Interest rate disclosure NOT required, thus:
- Implicit interest rate can be estimated by calculating the IRR of the finance lease payments
- Implicit rate can then be used to get PV of operating lease payments (goes on liability)
Question 7.
Accelerated Depreciation
ANSWER
Lower NI early years, greater later on. Most common accelerated depreciation is double
declining balance
, Question 8.
Warning Signs of Misstated Profitability (Biased Accounting)
ANSWER
- Rev growth higher than peers
-Receivables growth higher than rev growth
- High rate of customer returns
-Unexplained operating margin boost
-Operating CFs (OCF) lower than operating income
Question 9.
Restating for Inflation (IAS)
ANSWER
1. Nonmonetary assets and liabilities - restate using a price index from acquisition date to
balance sheet date. Revalued assets indexed from date of revaluation.
2. Monetary assets and liabilities are not restated
3. Equity is restated by multiplying the change in the index from the beginning of the period,
or date of contribution if later, to the balance sheet.
4. Revenues and expenses are restated by multiplying the change in the index from the
transaction date to the balance sheet date
5. A purchasing power gain or loss is recognized in the I/S based on the net monetary asset or
liability exposure
(applies to both GAAP AND IFRS)
- Net monetary asset exposure = loss, because purchasing power of money amounts has been
eroded by decline in exchange rate.
- Net monetary liability exposure = gain
FREQUENTLY TESTED ACTUAL EXAM QUESTIONS WITH
CORRECT ANSWERS
Question 1.
Mechanisms to misstate assets/liabilities (Biased Accounting)
ANSWER
- Choosing inappropriate models and/or model inputs that affect estimated values of financial
statement elements
- Reclassification from current to non-current
Over- or understating allowances and reserves
-Understating identifiable assets (and overstating goodwill) in acquisition method accounting
for business combinations
Question 2.
Internal Development Costs - R&D
ANSWER
IFRS
- Research costs are expensed as incurred
- Development costs are capitalized
GAAP
- R&D are expensed as incurred, except for software development costs
,Question 3.
Cash Flow Based Accruals
ANSWER
GAAP
-Div recieved, interest paid, interest recieved - CFO
-Div Paid - CFF
IFRS
-Div recieved - CFO if finance company, CFI otherwise
-Interest received - CFO, or CFI
-Interest paid - CFO (interest is part of normal biz), CFI
-Dividend Paid - CFO or CFF
Question 4.
Revenue Recognition Steps
ANSWER
1. Understand the rev recognition practices - shipping/credit terms, returns policy, multiple
deliverable, practices of peer group companies
2. Evaluate ageing of receivables - time series, cross sectional (peer group) comparisons
3. Cash vs accruals - cash vs accruals-based earnings evaluation
4. Compare financials with physical data provided by the company: Capacity utilization levels,
order books
5. Compare revenue trends to peers: use segment analysis
6. Check for related party transactions: transactions with associates, transfer pricing
,Question 5.
Consolidation of SPEs
ANSWER
IFRS consolidation when sponsor has control, indicated by:
- SPE benefits sponsor
- Sponsor makes decisions
- Sponsor absorbs rewards and risks
- Sponsor has residual interest
GAAP says an SPE is a VIE (and must be consolidated) if any are met:
- Insufficient risk. Investment in equity is less than 10% of assets
- Major shareholders lack decision making rights, and don't absorb expected losses, and do
not receive expected residual retirms
Question 6.
Lease Disclosures
ANSWER
Required to disclose:
- Lease payments for each of the next five years
- Aggregated payments beyond 5 years
Interest rate disclosure NOT required, thus:
- Implicit interest rate can be estimated by calculating the IRR of the finance lease payments
- Implicit rate can then be used to get PV of operating lease payments (goes on liability)
Question 7.
Accelerated Depreciation
ANSWER
Lower NI early years, greater later on. Most common accelerated depreciation is double
declining balance
, Question 8.
Warning Signs of Misstated Profitability (Biased Accounting)
ANSWER
- Rev growth higher than peers
-Receivables growth higher than rev growth
- High rate of customer returns
-Unexplained operating margin boost
-Operating CFs (OCF) lower than operating income
Question 9.
Restating for Inflation (IAS)
ANSWER
1. Nonmonetary assets and liabilities - restate using a price index from acquisition date to
balance sheet date. Revalued assets indexed from date of revaluation.
2. Monetary assets and liabilities are not restated
3. Equity is restated by multiplying the change in the index from the beginning of the period,
or date of contribution if later, to the balance sheet.
4. Revenues and expenses are restated by multiplying the change in the index from the
transaction date to the balance sheet date
5. A purchasing power gain or loss is recognized in the I/S based on the net monetary asset or
liability exposure
(applies to both GAAP AND IFRS)
- Net monetary asset exposure = loss, because purchasing power of money amounts has been
eroded by decline in exchange rate.
- Net monetary liability exposure = gain
